www.pabraifunds.com Mohnish Pabrai Managing Partner Dhandho! Low Risk + High Uncertainty = High Rewards
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Mohnish PabraiManaging Partner
Dhandho!Low Risk + High Uncertainty = High Rewards
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Defining Dhandho
• Mr. B. U. Patel – Founder/CEO of Newport Beach, CA based Tarsadia Hotels – Probably the richest South Asian in Southern California.
• From a 20-room Anaheim, CA motel to 4400 rooms - a 28-year Dhandho journey.
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The Patel-Motel Dhandho Model
• Refugees from East Africa – Strong entrepreneurial drive with nothing to lose.
• Buy a small single model with the family living in and working all the facets of the motel. • Highly leveraged. No downside.• Maximize cash flow and reinvest in another motel.
Heads - I win! Tails - I don’t lose much!
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• The Patel-Motel ends up being the lowest priced provider due to an intense focus on operating costs.
• Porter would call this “Sustainable Competitive Advantage” and make it a book.• Buffett would call it a “Moat”• Mr. Patel would scratch his head and say … Dhandho?
• 1/3 of all motels in the US are Patel Owned.• Over 20,000 motels – Over $40 Billion in Value.
The Patel-Motel Dhandho Model
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Enduring Arbitrage Spreads
Nearly all successful startups step in to fill a gap – some arbitrage spread that exists.Eventually virtually all gaps close
Some can close in a few months and others can persist for decades.
The Patel-Motel Arb is low cost producer and hence low cost provider.
As they scale this diminishes.As they compete with other Patels, its gone.
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Dhandho is Business Arbitrage
Not only are Dhandho entrepreneurs not risk takers, they are arbitrage players.
30 Miles
• Start with 1-2 Chairs.• Charge a bit more.• Expand as business grows• Upside: Good; Downside: Minimal• Eventually premium disappears.Town A
Pop: 40,000
Town BPop: 30,000
Emerging Town CPop: 200 to 1000
Heads I Win; Tails I Don’t Lose Much
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The Birth of Virgin Atlantic
How much does it cost to start a trans-Atlantic airline with a Boeing 747?
Airplane Cost, Reservation System, Advertising/Branding, Ground Staff, Crews …
Virgin started with no written business plan and total outlay of under $500,000. Maximum loss with total failure was under $3 Million.
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Virgin Atlantic Dhandho
The “mental business plan” was done in one weekend by 1 person with zero experience in airlines.
No elevator pitch, no VCs, no board, no advisors.
Capital-intensive business started with virtually no capital.
Found a gap and saw a way to exploit it.
Dhandho Arbitrage
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The Virgin Group
200 companies; 25,000 people; $7 Billion Revenue
Common theme for all businesses – virtually no capital to start-up. Classic Dhandho. The VC model of the future. All start with Dhandho arbitrage and brand.
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Low Risk + High Uncertainty = High Rewards
The Patels and Branson:
Twins separated at birth?
Both took virtually no risk. However, they had tremendous uncertainty about the future.
The odds of getting a high return on their investment were very high.
No brainers!
This framework is a very powerful one for equity investors to use.
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Some stocks have a very murky future.Markets, even efficient markets, have a very hard
time with these type of stocks.Canadian Oil Sands: What is the future price of oil?Covanta: Future electric rates and tipping fees?Silicon Valley Bank: What are those warrants worth?Frontline: What are future charter rates for tankers?Level 3 Bonds: Will they survive or go bankrupt?
Low Risk + High Uncertainty = High Rewards
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Pinnacle Airlines – Ultra Low Risk
Market Cap: $190 Million (PNCL)
Excess Capital: $90 Million ($4.09/share)
2006 Net Income: > $2.25/shr. (9 Mos. = $1.87)
Net Stock Price: $8.62 less $4.09 = $4.53
Net P/E Ratio: 2
Liquidation Value: $210 Million ($9.55/share)
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Ultra High Uncertainty
Single Customer – Northwest Airlines
What will the new NWA contract look like?
EPS: From $2.50/share to $1.75? $1.50?
Use of Excess Capital?
Future Northwest Relationship?
New Pilots Contract – what will change?
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Ultra High Reward Potential
Symbiotic Relationship – Hard to severe.
Pinnacle is an extremely low-cost, efficient operator.
Next few years are like to be very good for US airlines.
Regional Jet Sales are likely to take-off.
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Pinnacle’s Pedigree
On the Magic Formula ($1/25 Search)
Highest Earnings Yield on the List (38%)
Pre-Tax Return on Capital > 100%
Write-up on Value Investor’s Club – 6.2 Rating
Only 3 stocks (out of hundreds) have a rating above 6.2 in last 6 months!
Disclaimer: Do your own independent research!
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Publisher: John Wiley
April 6, 2007
Pre-order your copy on Amazon today!
Thank you!
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Thank You.
Mohnish PabraiManaging PartnerPabrai Investment FundsIrvine, California, USA
Tel. +1949.275.5652
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